Retirement Tax Planning and Tax Rates
Retirement tax planning is based on a simple equation. As taxes go up, disposable income goes down. Knowing that, we have to make an educated guess on what may happen with tax rates in the future. (For specific tax questions or advice, please consult your CPA)
There are some issues we know are problematic:
- High National Debt
- Social Security
Keep in mind, Social Security and Medicare account for 42 percent of Federal program expenditures in 2017!
If you think tax rates are going to increase to cover these shortfalls, then you have to be prepared for potential lower income in retirement to cover the tax shortfall.
Deferred Taxes Can Impact Retirement Savings
It’s not only the potential tax rate increases you should be concerned about. There is also the “Hidden Tax Bomb” that is lurking in retirement savings plans.
It was great putting away retirement funds on a pre-tax basis while you were working. What a nice gift from the government…right? Maybe and maybe not. Unfortunately, it is a gift that comes with a string attached. Namely, you just kicked the tax can down the road. Eventually, you will have to start paying the taxes on those savings at some point point the future.
The real kicker, for some people, is they may be in a higher tax bracket at retirement than when they were working and therefore may end up paying even more taxes on their deferred savings! This is true especially if you have other sources of income such as rental income, Social Security, pensions,etc. In this case, it is not uncommon that many people fall into the category of not really needing to take withdrawals from their retirement savings accounts such as 401Ks, IRAs. However, the government requires you by the age of 70 1/2 to start pulling your money from your 401Ks and IRAs whether you want to or not. It is this scenario that can create additional unwanted income that costs your hard earned savings to be paid into taxes, and often moving you up into a higher tax bracket.
The other issue with deferred savings is that because of the tax issue, the balance you see isn’t really the balance you get. Many people have said…”Wow..I have saved $1,000,000″ and that is great! You just have to keep in mind that you have a silent partner, the US Government, that is going to get portion of your savings.
So remember, if you are not needing to supplement income with your IRA or 401K, once you reach age 70 1/2, required minimum distributions may force you to take unwanted withdrawals, in effect, pushing you into a higher tax bracket costing more of your hard earned savings going to taxes.
Isn’t it easier to plan for something now versus waiting until a problem exists than try to fix it?
If you do need to supplement your retirement income prior to age 70 1/2, isn’t it a good idea to know how the changing tax laws could impact the longevity of your 401k and IRA retirement savings? Therefore, it is very important to understand the role taxes play on your retirement savings during retirement.
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Example: Owing Taxes On Your Retirement Savings
Congratulations! Imagine you have accumulated $1,000,000 for retirement in your 401k! I hate to be a bearer of bad news but you do not really have $1,000,000 to spend. In reality, it is $1,000,000 less taxes! If you had to pay 20% in taxes over your retirement, you really have only $800,000 ($1,000,000 – 20% (or $200,000) = $800,000). If you account for a hypothetical 4% withdrawal rate, your annual withdrawal from $1,000,000 would go from $40,000 to $32,000 per year. Per month, you would go from $3,333 to $2,666 a difference of $667 per month! What more could you do with $667 per month instead of paying it to taxes!
Add in inflation and it gets even worse! The $2,666 monthly check you receive loses about 3% per year to inflation (on average). So in order to not deplete your savings over time, you have to at a minimum get a 7% return. Any down years, and you have to make that up in subsequent years.
Retirement savings plans were originally sold on the idea you would be in the lowest tax bracket at retirement. The resulting taxes in retirement would be lower than when you were working thus making it a financial win. The reality is many retirees are finding they are in the same or higher tax bracket because of alternate income sources (rental property, pensions, consulting work, etc). Per the 2018 tax tables, married filing jointly with income over $77,400 are in the 22% tax bracket. It’s pretty easy to get bumped up from the lowest bracket!
At the end, we are at the mercy of the US Government. We don’t know what taxes are going to do over the next 30 years of retirement but wouldn’t it be good to have a plan for addressing the tax rate risk? Just like the example above, using 20%, what if taxes went up to 30% causing you take another $4,000 annually from your savings to cover taxes? Are your retirement savings protected from an increasing tax risk? If not, lets us help you protect your savings against taxes.
Having A Proper Tax Strategy Can Make A Difference
Two of the goals at retirement are protecting your income against increasing taxes and mitigating the impact of higher taxes on deferred savings withdrawals (i.e. 401ks, IRAs, etc). Effective tax planning strategies and the use of specific tax friendly financial tools, can help ensure more of your money stays in your pocket at retirement. You will pay taxes but how much you pay can often be controlled by you.
People who have large 401k or IRA accounts as well as other income sources (rental property, pensions, residual income, ect) may find they are in a HIGHER tax bracket and paying more in tax on their required RMD withdrawal than when they were working.
On top of that, imagine having your taxes increase while the market is declining…Talk about a double whammy!
Fixed index retirement annuities are one solution for mitigating unknown tax rates and uncertain market directions because they are fixed income financial products that do not expose you to financial risk.
Fixed index annuities offer:
- Tax deferred growth
- Benefit of participating in market growth
- Assurance of never losing money in down markets
- Protected retirement income guaranteed for life – while maintaining liquidity of your assets
- Income options that guarantee annual increases
- Accelerated Benefit riders to cover chronic and terminal illnesses
- Peace of mind…Never outliving your income!
For retirees concerned with uncertain taxes and market losses, fixed index retirement annuities are a popular solution.
When you retire, you may have multiple choices regarding sources of retirement income such as retirement accounts, risk based investments, fixed interest rate investments, annuities life insurance, Social Security, etc. In order to minimize taxes at retirement, careful choices need to be made about which of these sources to use first. It is recommended that you consult with your accountant regarding specific tax questions as each persons situation is unique. The point being there are strategies that can be employed to help potentially reduce the effects of taxes on your retirement income and financial tools that can stabilize and protect your retirement income. At this stage in the game, every penny counts!
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